Social Capital is Good Economics, too

My opinion piece in today's Australian Financial Review discussed how social capital can not only be good for our society, but also for our economy.

Connections Add Value, Australian Financial Review, 12 October 2010

Once a year, Roy Morgan runs a pollsters’ beauty pageant, asking respondents to rate the ethics and honesty of various professions. This year, just 16 percent gave business executives a rating of ‘high’ or ‘very high’. This places CEOs on par with federal MPs, and only a smidgin above the lowest-ranked professions such as car salesman, real estate agents and journalists.

Declining trust in business leaders since the 1970s is part of a general collapse in social capital in Australia over recent decades. In a new book, Disconnected, I crunch data from membership records and surveys and find troubling patterns across the nation. Organisational membership is down. We are less likely to attend church. Political parties and unions are bleeding members. Sporting participation and cultural attendance is down. We have fewer friends and are less connected with our neighbours. Just as Robert Putnam’s Bowling Alone mapped the collapse of social capital in the US, my own research finds similar patterns in Australia.

From a community perspective, the decline in social capital is troubling because it means that the network of friends and neighbours that sustains us through hard times is less resilient than in the past. But what is sometimes missed is that social capital matters for business too. If you trust your supplier, it is easier to strike a deal than if you need to spell out in the contract all the ways they might exploit you. In a joint venture, it is often impossible to spell out all the potential pitfalls, so a sense of shared purpose is essential to any good agreement.

Not only does trust helps grease the wheels of commerce – commercial relationships can help build trust. One of the first to recognise this was the brilliant Adam Smith, who wrote: ‘Whenever commerce is introduced into any country, probity and punctuality always accompany it. These virtues in a rude and barbarous society are almost unknown.’

Smith pointed out that when two people are repeatedly interacting with one another in a market, they are more likely to behave well towards one another. ‘When a person makes perhaps 20 contracts in a day, he cannot gain so much by endeavouring to impose on his neighbours, as the very appearance of a cheat would make him lose.’

In the modern economy, it is easy to see plenty of instances in which trust and commerce run together. A plumber who turns up on time and charges the quoted price is a guy you will likely hire again. The barista with a smile helps ensure that her customers will come back for their next day’s coffee. A boss who encourages workers to knock off early on quiet days is more likely to find employees willing to stay a little longer when times are busy.

Where one finds exceptions to Smith’s theory are in occupations where the transaction is a one-shot deal (think of buying a car or house, or hiring a removalist). So it is not surprising that unscrupulous behaviour is more common in those industries. But this is not the norm, as the typical business transacts again and again with the same set of customers, suppliers and workers.

For jobseekers, social connections are an invaluable connection to the world of work. As Stanford University sociologist Mark Granovetter famously wrote, what matters in getting a new position is having a large network of ‘weak ties’. When it comes to finding out about new openings, an acquaintance can be as helpful as your best friend. And because you have more acquaintances than close friends, the odds are that your perfect job will come through an acquaintance.

Yet while the evidence strongly suggests that social capital boosts economic development, trust and civic engagement are often regarded as peripheral to economic policy. The debate over social capital today recalls the economic argument of the 1960s, in which economists on opposite sides of the Atlantic disagreed about whether ‘human capital’ was a viable concept. In a generation’s time, I expect that social capital will be as uncontroversial to economic thinkers as human capital is today.

Which brings me back to those much-maligned CEOs. If trust really matters for economic performance, can it really be true that the best executives are unethical and dishonest? To test this, economists Ernst Fehr and John List ran a set of experiments with two groups: undergraduate students and CEOs. They found that CEOs were in fact much more trustworthy than students, perhaps because business leaders are more used to striking deals and sticking to them. Still, it may be some time before executives can confidently say, ‘Trust me – I’m a CEO’.

Andrew Leigh is the federal member for Fraser. Disconnected is published by UNSW Press.

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